If we closed the capital-gains loophole, we could put every child in America on track for success.

February 18, 2016

Millions of Americans sweat and strain at work every day. They lift. They pound. They come home exhausted. Other Americans make their living wheeling and dealing on Wall Street. The most strenuous part of their day? Trying to stand up after lunch at a five-star restaurant.

This special feature was written by a team at the Institute for Policy Studies. You can learn more about their work at inequality.org.

Which Americans deserve preferential treatment at tax time? Under our current tax law, the preference goes to those who make the bulk of their income from buying and selling assets. Wealthy Americans pay just $23.80 in federal income tax on every $100 of this “capital gains” income. Ordinary income, by contrast, faces a federal tax rate that can go as high as 39.6 percent. In other words, for every $1 million of wheeling-and-dealing income that billionaires claim, the capital-gains tax preference shears about $160,000 off their tax bill.

You can do a lot with $160,000. For example, you could cover the tuition costs for a couple of children in America’s priciest preschools. And if you revised the tax code to end this preferential treatment, you could cover the cost of preschool for every child in America.

All children need a high-quality preschool experience. According to the national advocacy group First Focus, pre-K programs “can have a significant and lasting positive impact on the health and development of young children.” The social impact may be just as important: The Nobel Prize–winning economist James Heckman has calculated that public investment in early-childhood programs generates a 7 to 10 percent annual “return to society.”

Ending the preferential treatment for capital-gains income would raise an estimated $600 billion over 10 years.

Affluent families can afford to get their kids on track early for success. Other families can’t. In North Carolina, only 1,300 of Forsyth County’s 4,000 4-year-olds have a place in a childhood-education program, and state legislative cuts have left a waiting list over 500 deep for slots in publicly funded programs for low-income youngsters. In Indiana, a new preschool pilot program for poor children had to turn away 57 percent of those kids who applied for it.

Recognizing the need for a national commitment to early-childhood education, President Obama called for universal pre-K in his 2013 State of the Union address. His subsequent proposal to create a federal preschool program for all 4-year-olds from low- and moderate- income families carried a $75 billion price tag. The president called for higher taxes on tobacco to help fund his plan, but that idea went nowhere in Congress. Axing an obscure tax-code provision known as the “carried-interest loophole,” however, could generate the revenue needed to fund this ambitious plan.

No one in the United States takes advantage of the carried-interest loophole more than hedge-fund managers and their billionaire brethren running venture-capital and private-equity funds. With a bit of fancy accounting, these high-flying financiers get to define the share of the profits they make buying and selling other people’s assets as capital gains. In other words, investment-fund managers don’t just get preferential treatment on their capital-gains income; they get to redefine their ordinary income as capital gains.

How much does this handy little loophole cost the US Treasury? The conventional estimate, from Congress’s Joint Committee on Taxation, is about $18 billion over 10 years. But veteran tax analyst Victor Fleischer puts the cost at $180 billion—10 times that amount.

Ending all of the preferential treatment for capital-gains income would, of course, dramatically enhance the government’s ability to ensure universal pre-K for the next generation of Americans. Citizens for Tax Justice estimates that such a move would raise $600 billion over 10 years.

In the 2015 fiscal year, the government spent just $15.4 billion on all early-childhood programs combined. Parents across the country are increasingly frustrated with the inadequacy of this support. Channeling that frustration into a national movement to end preferential tax treatment for capital-gains income could help make universal pre-K a reality.

Marc Bayard Marc Bayard is the director of the Black Worker Initiative and the coauthor, with Kimberly Freeman Brown, of the recent report “And Still I Rise: Black Women Labor Leaders’ Voices, Power, and Promise.”

John Cavanagh John Cavanagh is the director of the Institute for Policy Studies and author, most recently, of Development Redefined: How the Market Met Its Match (with Robin Broad).

Josh Hoxie Josh Hoxie is the director of the IPS Project on Opportunity and Taxation and the coauthor of the report “Billionaire Bonanza: The Forbes 400 and the Rest of Us.”

Sam Pizzigati Sam Pizzigati, an Institute for Policy Studies associate fellow, is the author of The Rich Don’t Always Win: The Forgotten Triumph Over Plutocracy That Created the American Middle Class, 1900–1970 (Seven Stories Press). With Chuck Collins, he edits Inequality.Org.

In 1946, then Chairman of the NY Federal Reserve, Beardsley Ruml wrote: " ... with an inconvertible currency, a sovereign national government is finally free of money worries and need no longer levy taxes for the purpose of providing itself with revenue... It follows that our Federal Government has final freedom from the money market in meeting its financial requirements... All federal taxes must meet the test of public policy and practical effect. The public purpose which is served should never be obscured in a tax program under the mask of raising revenue." He goes on to explain how, with Federal spending not revenue constrained, the first function of taxation is to regulate the value of the dollar, which we know as regulating inflation. The notion of the Federal government 'running out of money' and 'dependence on foreign borrowing' as well as 'sustainability' is categorically inapplicable.

The foregoing notwithstanding, today most discussions on tax policy begin with a false premise. Namely, that tax revenue funds Federal government expenditures. It doesn't. All the Federal government needs to complete the act of spending is an appropriation. As the sole issuer of dollars it never needs to "get" them from us in any fashion so that it can spend. It simply creates more of its dollars electronically. It has to spend dollars before it can tax.

What too many also conflate is the legislative requirement for record keeping with the actual reality of what the government does and what the dollar is, operationally.

"One of the strangest things to understand about Modern Money (post domestic gold standard 1933) is why, if government doesn’t need your tax dollars in order to spend, does government tax at all? (Government taxes to manage inflation/aggregate demand and income distribution, but not to fund itself.) Here is an attempt at a new and “better” explanation. It is based on the insight that the government DOES, in fact, need to collect taxes, but the “taxes” it collects are not your “tax dollars.” This may sound like gibberish, but stick with me a moment and see if the following doesn’t make sense—and cast a new light on OTHER things as well (like, for example, the “national debt”).

A paper dollar, printed by the sovereign U.S. government, is nothing more—and nothing OTHER than—a tax I.O.U. which states, in effect: “The sovereign U.S. government owes the bearer one dollar of tax credit on the day taxes are due.” http://goo.gl/zOrU5X

Because of this I.O.U. pledge, the government is able to use the paper dollar, in the MEANTIME, to purchase real goods and services from private citizens and businesses. The citizens and businesses are willing to exchange their real goods and services for the paper dollars because they will NEED the I.O.U.s (dollars) to present to the government on “tax-day”. The mental “trick” here is to realize that the ACTUAL taxes are collected when the government purchases the real goods and services—those goods and services being, in fact, the actual taxes paid. (This is perfectly logical, when you consider it, because what the government WANTS are the goods and services—NOT its own paper I.O.U.s which it can print up any time it wants.)

What happens on “tax-day”, then, is the citizens present the sovereign government with the paper I.O.U.s they have earned providing goods and services to the government (and/or to each other), and their taxes are extinguished. Again, the mental “trick” here is to realize that the transaction that takes place on “tax-day” is not actually the PAYMENT of taxes but, instead, is the citizens declaring they have ALREADY paid their taxes (the real goods and services they provided earlier)—and the paper I.O.U.s are the PROOF of that payment.

By logic, then, what does the government do with those I.O.U.s presented as proof of taxes paid? They are simply destroyed because owning a piece of paper that says you owe YOURSELF one dollar of tax credit is meaningless. The I.O.U. is only of value to the citizen who is required by law to pay taxes, and once it is used for that purpose, it is extinguished.

This perspective supports and, I think, clarifies the general Modern Money propositions that:

a) Taxes drive money—in other words, private citizens are willing to provide goods and services to the government in exchange for government’s paper dollars because they NEED those dollars (government I.O.U.s) to pay their future taxes.

b) The government must create and then SPEND its dollars in order for the private citizens to earn the dollars they need to pay their taxes.

c) When the government collects “tax dollars” it is NOT collecting something it “needs” but, instead, is simply collecting back (or cancelling) its own I.O.U.s (The ACTUAL taxes are the real goods and services it had previously received in return for those I.O.U.s).

d) Because the government imposes a continuous, outstanding tax liability on its citizens and businesses, the paper I.O.U.s (dollars) have value in the private market and become the standard currency of exchange for goods and services between private citizens and businesses.

e) In order for this private sector economy to grow, the government has to spend MORE I.O.U.s (dollars) than it collects back (cancels) on tax-day. If it does NOT spend more than it collects, the private citizens and businesses will have no “net” dollars for private commerce and, as a consequence, there will be fewer real goods and services for the government to purchase.

The more I.O.U.s the government spends, relative to what it collects back in taxes, the MORE net dollars remain in the private sector economy and, assuming the real resources are available to put those dollars to work, the economy will add jobs and produce more goods and services.

f) Because the government must spend MORE dollars (I.O.U.s) than it collects back (cancels) on tax-day, it appears to be “deficit spending”—spending more than it “earns”.

This terminology is logically MISLEADING, however, because the only thing the government can “earn” by collecting “tax dollars” is its own I.O.U.s which cannot be a form of “earning” in any meaningful sense of the term, since it is meaningless to own a piece of paper that says you “owe yourself.”

This brings us, then, to the question: If a paper dollar is a tax I.O.U., what is a Treasury bond? The common understanding is that Treasury bonds represent a “debt” which the government must “repay” in the future. But look how our new perspective requires that view to shift:

Let’s say a private citizen “buys” a Treasury bond. What takes place? The citizen exchanges say a hundred paper tax I.O.U.s for another piece of paper (the Treasury bond) which is…what? It is another government tax I.O.U. pledging to pay, at a specified time in the future, a hundred and SEVEN paper tax I.O.U.s (the original hundred plus 7 percent interest.) What is unique in this transaction is that, while it appears the government is in “debt” to the citizen, what it “owes” the citizen is nothing more than its own promise to accept these I.O.U.s (dollars) as tax payments. There is no logical sense I can think of in which that can be considered a meaningful debt.

The national “debt crisis” which our enlightened politicians and economic pundits flail us with on a daily basis—demanding our obeisance to their schemes of imposed austerity—cannot, therefore, really EXIST. It is a figment of their overwrought imaginations. Simple reason tells us that—so long as the sovereign government has the authority to declare that its citizens shall pay taxes—it is an effortless exercise for that government to continuously and FOREVER issue pieces of paper which simply state the government will accept that paper as payment of taxes due to itself. The implications of this for a TRUE national prosperity are enormous."

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Doug Barrsays:

February 18, 2016 at 1:09 pm

There is no secret to funding the life in which we would all feel most alive from beginning to end. Simply raze the vertical economy. We raised it. We can raze it. http://thelastwhy.ca/poems/2012/12/13/economy.html